Policy Brief: A Future Fund for the Philippines

This policy brief sets out the basic rationale, legal framework and economic/financial feasibility of setting up a fund out of the nation's international reserves to support human capital formation. As argued in this paper, the demographic dividend that the Philippines is poised to reap in the coming decades is contingent on developing its most important asset: people.

The Father of QE3

Now that QE3 is nearly upon us, it is worth understanding the rationale behind it from the man responsible for developing the views of policymakers. Tyler Cowen, the man responsible for giving prominence to his ideas declared September 13 "Scott Sumner Day" after the US Federal Reserve announced that it would engage in a third round of quantitative easing. Here is the man responsible for this new course of action by the Fed:

China Before the Fall?

There is somethings seriously wrong with this picture:

China's dependence on investment (accounting for almost half of its economy in 2009) means that any slowdown in investment will lead to something akin to a "hard landing" in the West (an abrupt correction of monetary and fiscal policy leading to a contraction). Having experienced double digit growth since the 1980s, a hard landing in China would mean less than stellar growth of 7-8% triggering higher unemployment. Nouriel Roubini who warned investors against US sub-prime mortgages has predicted with "meaningful probability" that this slowdown of investments will occur in 2013.

Back in 2008/09, China got a foretaste of what is to happen when it grew by a mere 6.6% in the first quarter and consequently saw 20 million migrant workers in urban centers losing their jobs. The stimulus measures put in place to boost domestic consumption and investment might be coming back to bite the economy with much of this spent on redundant infrastructure (as Nouriel Roubini noticed when he took the hi-speed train from Shanghai recently) or lent to local governments and state owned companies leading to a property and debt bubble.

One phenomenon that has come out of this are the so-called ghost towns built by local governments with stimulus lending. Andie Xie, former chief Asia economist for Morgan Stanley has called China's stocks a big ponzi scheme and warns of either a US or Chinese crash in 2011.



Indeed investors have begun to question the sound governance of Chinese companies. Another leading indicator is inflation. With Premier Wen Jiabao now hinting that it cannot be contained within the government target of 4 percent, meaning that the government is unwilling to lift interest rates in the near term fearful of the effects that would have on growth, the scene is set for an abrupt correction of policy settings leading to a hard landing.

Cost of Stimulus: $50B, Confidence to Shop: Priceless

Here is a neat claymation video on the topic of stimulus (economic or otherwise) produced by the Econogirl courtesy of the National Times. Very witty.

http://media.theage.com.au/opinion/national-times/econogirl-on-stimulus-withdrawal-780804.html

The Australian Contagion

The past week saw global markets move in response to the announced hike of interest rates by the Reserve Bank of Australia. It was taken as a sign of global recovery, Australia being the first of the G20 (Group of 20) countries to come out of its downturn. The Australian dollar approached levels not seen in over a year (chart below produced from Yahoo!7Finance).

PM Kevin Rudd was criticised by the "doyen of Labor economic advisers" Ross Garnaut for his social democrat inspired stimulus package in response to the global financial crisis.

The secretary of the treasury, Ken Henry quickly defended the government response by highlighting the counterfactual scenario of an additional 100,000 unemployed and more prolonged downturn without the spending.

The latest unemployment figures seemed to support this with an unexpected drop in the unemployment rate and a rise in the number of hours worked. This was in stark contrast to the unexpected increase in the number of workers unemployed in the previous month in the United States. The Dow Jones industrial average took it all in stride ending up at new highs for the year.

Latest polling figures show the Labor government having a seemingly supreme advantage over the Liberal opposition, a result that has fuelled speculation over the fate of its leader Malcolm Turnbull.

Turnbull having staked his leadership on climate change policy was castigated by former Treasurer Peter Costello as he announced his early retirement from Parliament.

With the current government riding high on a wave of both local and international respect, the early election scenario now seems a distant possibility as Treasurer Wayne Swan predicted a better than expected result for the budget prior to the release of the Mid-Year Economic and Fiscal Outlook.

Having coupled itself to the Chinese and emerging Asian economies which have exhibited resilience against the global financial crisis and having relatively little exposure to the sub prime markets, Australia finds itself in the best of all possible worlds with the growing demand for its mineral exports triggering a huge investment project off the Western Australian coast.

The challenge for the government now would be to manage both in the near and medium term the steady unwinding of government stimulus. The first part was accomplished with the phasing out of the top-up stimulus to the housing market announced last year. The withdrawal of bank guarantees is being thoroughly studied but is proving difficult. Winding back of monetary stimulus has already begun in earnest.

With monetary and political business cycles not in sync, expect monetary and fiscal policy to be in continued conflict for the next twelve months or until the next election, whichever comes sooner.

Opposite Poles

Two eminent economists, Meltzer and Krugman, dispute the issue of whether inflation or deflation will be the next great challenge facing the US (and world) economy. A lot depends on which period of history is used as an analogue for this one.

Allan H. Meltzer is a professor of political economy at Carnegie Mellon University. He has authored the book “A History of the Federal Reserve.” He believes that the US is headed for “severe inflation”. In an op-ed piece for the NY Times, he points out that

the interest rate the Fed controls is nearly zero; and the enormous increase in bank reserves — caused by the Fed’s purchases of bonds and mortgages — will surely bring on severe inflation if allowed to remain (Inflation Nation, 3 May 2009).

He pins the blame on both political and monetary authorities, in particular

the (doubtful) commitment of the administration and the (lack of) autonomy of the Federal Reserve ... under Mr. Bernanke, the Fed has sacrificed its independence and become the monetary arm of the Treasury: bailing out A.I.G., taking on illiquid securities from Bear Stearns and promising to provide as much as $700 billion of reserves to buy mortgages.…
It doesn’t help that the administration’s stimulus program is an obstacle to sound policy. It will create jobs at the cost of an enormous increase in the government debt that has to be financed. And it does very little to increase productivity, which is the main engine of economic growth.

Meltzer recounts the Fed under Paul Volcker (who is presently advising the Obama administration) which tamed spiralling inflation following the Oil Shock of the 1970s. As some have argued, the present crisis could have been instigated and deepened by the Oil Shock of 2007. Meltzer further points to one indicator that inflation is already here; he argues

(S)ome of my fellow economists, including many at the Fed … point to the less than 1 percent decline in the consumer price index for the year ending in March as evidence that deflation is a threat. But this statistic is misleading: unstable food and energy prices may lower the price index for a few months, but deflation (or inflation) refers to the sustained rate of change of prices, not the price level (emphasis mine). We should look instead at a less volatile price index, the gross domestic product deflator. In this year’s first quarter, it rose 2.9 percent — a sure sign of inflation.

Quoting the father of monetarism, he says

Milton Friedman often said that “inflation was always and everywhere a monetary phenomenon.” The members of the Federal Reserve seem to dismiss this theory because they concentrate excessively on the near term and almost never discuss the medium- and long-term consequences of their actions.

Paul Krugman is on the opposing side of the debate. He teaches at Princeton University and has made a living out of studying economic crises. His latest book is entitled “The Return of Depression Economics.” He counters Meltzer in his blog with a graph that depicts the “lost decade” in Japan in the 1990s where the growth of money supply, high deficits coincided with deflation. Krugman’s attention is devoted to avoiding wage deflation, as he writes in his column for the NY Times that

…according to the Bureau of Labor Statistics, the average cost of employing workers in the private sector rose only two-tenths of a percent in the first quarter of this year — the lowest increase on record. Since the job market is still getting worse, it wouldn’t be at all surprising if overall wages started falling later this year (Falling Wage Syndrome, 3 May 2009).

His view is that wage deflation is a symptom of a deeper problem in the economy. And his prescription is for “more stimulus, more decisive action on the banks, more job creation”. Quoting the father of stimulus economics, he argues that

(T)hings get even worse if businesses and consumers expect wages to fall further in the future. John Maynard Keynes put it clearly, more than 70 years ago: “The effect of an expectation that wages are going to sag by, say, 2 percent in the coming year will be roughly equivalent to the effect of a rise of 2 percent in the amount of interest payable for the same period.” And a rise in the effective interest rate is the last thing this economy needs.

So there you have it: two renowned experts fighting over the appropriate fiscal and monetary measures to take in this crisis. Both use staitstics and history to bolster their arguments. The disagreement ultimately comes from which previous recession is deemed relevant for this present crisis – whether the Great Depression of the 1920s and lost decade in Japan of the 1990s or the post-Oil Shock era of the 1970s.

Krugman and Bernanke, the deficit hawks, believe that constricting growth particularly at this moment could hamper economic recovery, while Meltzer, the institutionalist, believes that protecting growth at all costs has consequences far greater than we imagine.

Mo' money

This animated chart put together by Glenn Beck of Fox Cable News using Reserve Bank of St Louis figures, mimicking Al Gore's slide show, helps to visualise the exponential rate at which the US Federal Reserve is devaluing its currency by way of increasing the notes in circulation, or what is commonly referred to as “printing more money”. For those whose environmental sensibilities may be offended, please excuse the exuberance of Glenn as it is obviously aimed at the average Fox News subscriber.